Following the release of our first and second reports on Unilife (NASDAQ:UNIS), proponents of the long thesis have continued to defend the extreme valuation of the business. In contrast, our research continues to indicate that shares remain severely overpriced due to the poor underlying economics of the announced contracts and the extremely competitive landscape. Yesterday's Unilife earnings call seemed to corroborate our negative outlook as UNIS reported just $3.6m of revenue and a GAAP loss of -$16.3m for the quarter-ended December 31st. Management failed to provide new detail on existing contracts and no new deals were disclosed. Overall, the tone on the call was muted. The result should be disappointment for investors that have bid up UNIS shares by 40%+ rise since the last earnings call.

Earnings Reveal Continued Operating Losses and an Unclear Growth Plan

Unilife's fiscal second quarter results was a harsh reminder to shareholders that UNIS is an incredibly overvalued equity at best. Unilife reported precisely zero cost of goods sold ("COGS"), indicating that it failed to sell a single needle for the quarter. The reported revenue of $3.6m wholly consisted of previously reported milestone payments from Hikma and Sanofi in addition to other non-recurring revenue. Management was also guarded about potential new deals, stating that no new material contracts are signed that haven't already been reported. This may have shocked the many voices who flood $UNIS with daily Tweets promising "EXPONENTIAL GROWTH" or "2 CONTRACTS PENDING." The Twitter-chatter suggests that Unilife's recent share price appreciation was entirely driven by new contract announcements. Without a constant stream of new deals to prop up Unilife's share price, retail investors could begin abandoning the stock in droves.

Equally as alarming as the persistent lack of product sales is Unilife's accelerating operating losses. Unilife reported $15.5m in operating expenses and a negative operating loss of $11.9m. While cash burn was temporarily lessened by $10m in upfront payments from Hikma and Sanofi, Unilife still managed to burn $2.3m of cash according to last week's Australian filing. Over the last twelve months, Unilife has incurred more than $60m of operating expenses. Even if Unilife shifts some of these cash expenses into stock grants, UNIS is burning roughly $50m cash per year on an ongoing basis. This leads us to believe that the previously disclosed $20m in milestone payments for calendar year 2014 won't be close to covering Unilife's operating expenses.

Cantor Fitzgerald's analyst, who has been a UNIS bull in the past, also appeared worried about the ongoing cash burn, "[When] can we start to get approach of break-even point? Or is the ramp still early enough that may get pushed out to next year?" (FQ2 2014 Call). Unilife management refused to answer the question directly, saying "we're not focused on the next quarter or the next quarter of this year of every to midyear or the end of next year."

Unilife then had the gumption to compare itself to Amazon, "And I think I've said this to you, Jeff, it's very similar to the Amazon approach of not looking at that short-term." We wish Unilife luck in becoming the next Amazon and gaining Wall Street's acceptance with a business model of perpetual losses. But we doubt that current investors had this strategy in mind when speculating in UNIS shares.

Another glaring problem on the call was Unilife's lack of familiarity with its own financial statements. Never have we seen a supposedly half-billion dollar business fail to answer such seemingly basic questions. One analyst asked why Unilife's interest expense increased from $645k to $4.35m, a very reasonable question since there was no new debt financing. Unilife's management could only respond, "[CEO] Richard, can I pass that one to you? [CFO] If you don't mind I do need to look at that and get back to you Keith." A business with only $3.6m of revenue should understand the origin of an expense that more than eclipses its entire revenue stream.

Earlier on the call, another analyst asked Unilife to explain how the upfront cash receipts were treated in the income statement. Again, this concept would be understood in detail by a skilled management team. In response to the question, Unilife instead managed,

"[CEO:] Obviously, will work on the and we work with Accounts Department and other relations to deferred revenue. As you know, I've been away the last 4, 5 weeks. I haven't been involved in detail on that. [CFO:] As you might imagine, the deferred revenue essentially is primarily in 2 areas and that has to do with the nature of the revenue. So it's either milestone recognized or it is amortized over a period of time. So that's actually what you're going to see overtime and you're going to see a pretty big buildup of deferred revenue."

The specifics of the question, which Unilife failed to answer, are critical to Unilife's hypothetical growth story. Management stated that it expects "sequential quarterly revenue growth" through fiscal 2014. If this sequential GAAP revenue growth is only due to the amortized benefit of the Hikma and Sanofi milestone payments, then Unilife isn't actually growing. Instead, it would only be reporting previously disclosed milestone payments. Until this issue is clarified, we'd expect the sellside to become more cautious with their revenue projections and price targets.

The Dilution Continues

Unilife ended December 31st quarter with just $6.7m in cash reserves, covering about one month of operating expenses. This critically low cash balance demanded an immediate cash injection. In our most recent article, we argued that Unilife's secondary could be priced below $3.50, which was a 15 - 20% discount to Unilife's trading price at the time. While we were wrong on the precise amount, we were broadly correct about the discount. The secondary occurred on January 16th, with Unilife selling 1.5m additional shares at $4.25/share. This was well below the $4.75 - $5.00 trading price. The result was that Unilife managed to raise just $6.2m in proceeds after expenses, leaving it with about $12.9m in pro-forma cash at the start of the quarter. Even this adjusted cash balance remains well below Unilife's $10-15m in quarterly cash burn, suggesting that another highly discounted at-the-money offering could occur at any time.

Unilife attempted to ease these concerns with several hopeful remarks, "It is also my intention to avoid using the ATM in the foreseeable future" (FQ2 Call), but we remind investors that UNIS has made similar comments on past calls. Avoiding dilution has been a focus for each of the past three quarters, "With so many transformational agreements generating revenue immediately, we have no intention of doing any secondary stock offering that would cause dilution to existing shareholders" (UNIS May 9th 2013 Call); "What I want to do is minimize dilution, and that debt funding that the -- financing that's available to us at any time we wish to partake in it is another lever to which we may pull" (UNIS Sept 10th 2013 Call); "We have no plans to conduct any significant secondary offering, either now or in the foreseeable future" (UNIS Nov 11th 2013 Call). After each and every one of these comments, Unilife has issued stock under the at-the-money agreement. In the last four quarters, Unilife has received proceeds of $13.4m, $10.6m, $12.9m, and $6.2m from the issuance of dilutive secondary shares. Beware when management teams say one thing and then perform the complete opposite.

Unilife also referred to a potential debt financing arrangement with "a large healthcare investor." Given Unilife's high cost of equity and its ongoing cash deficits, the lack of a secured bank financing arrangement has always been a major red flag. When asked about the healthcare investor, UNIS admitted that "We had the option of putting a debt financing in place since I announced pretty much I think around May of last year" (FQ2 2013 Call). In other words, rumors of a new debt facility are inaccurate in our opinion; this deal is likely identical deal to the one mentioned in May 2013. Furthermore, we'd guess that a private market investor would demand an equity-linked option, such as warrants or a convertible. Private investors have a higher cost of capital than a bank. Until Unilife reports a detailed term sheet for this potential debt financing, investors should remain prepared for further dilution.

Conclusion

We continue to believe that Unilife's fundamentals cannot come close to justifying its $440m market capitalization. Past deal announcements have been full of triumphant rhetoric, each time boasting about transformative multi-billion dollar opportunities. But Unilife's ability to translate these contracts into substantial product revenue remains as elusive as ever. Once investors come to realize that Unilife's contingent partnerships do not guarantee meaningful product sales, the market should begin to focus on the fundamentals of the business. And based on yesterday's report and conference call, it's unclear that Unilife will ever produce a profit, much less deliver an acceptable return to investors.

Disclosure: The author is short UNIS. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Read our full disclaimer at kerrisdalecap.com/legal-disclaimer-3. This is not a recommendation to buy or sell any investment. We may transact in the securities of UNIS at any time subsequent to publication.